Beware Muni ‘Yield Hog’ Funds

By Brendan Conway

Municipal bonds and the funds holding them look compelling after the midyear selloff, which ushered in the return of the 5% muni. Just make sure your fund manager isn’t is a “yield hog.”

S&P Capital IQ mutual-fund analyst Todd Rosenbluth invokes the termthis week as he urges investors to be wary of managers who gorge on too many non-rated bonds. The non-rated segment is where most muni defaults are found.

Bloomberg

But default risk, it turns out, is just one of the ways to harm your portfolio, and not even the likeliest. Non-rated bonds are often less liquid. The lack of liquidity becomes a problem when everybody wants out — a danger that’s already come into play this year.

Watch out for fund managers with heavy overweights on the segment, Rosenbluth warns:

[W]hat strikes us as concerning about the tax-free municipal bond fund space is that some active mutual fund managers are comfortable investing most of their assets in bonds that do not receive a credit rating from Standard & Poor’s, Moody’s or Fitch. These managers rely on their internal credit research to support their decisions, but investors have little to go on but faith that the decisions to hold these bonds are warranted, in our view.

And here he is on the lack of a liquid market for the bonds if and when fickle fund investors once again decide to hit the exit, like they did in mid-2013:

[W]hen a fund has to sell non-rated bonds to support client withdrawals, it might have difficulty finding a buyer and this can further hurt a fund’s performance.

One easy rule of thumb: Be skeptical if your fund owns more non-rated bonds than the index. About 34% of the S&P Municipal High Yield Index was non-rated bonds at last check.

There are attractive yields to be had without venturing too deep into the risky stuff. Examples, from Rosenbluth: Eaton Vance High Yield Municipal Income Fund (ETHYX), yielding 4.7%, with about 20% non-rated bonds. T. Rowe Price Tax Free High Yield (PRFHX), 4.5%, 18% non-rated bonds.

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There are 4 comments

NOVEMBER 2, 2013 11:35 A.M.

Anonymous wrote:

Just an FYI - Puerto Rican debt is "rated".

NOVEMBER 2, 2013 11:35 A.M.

Jeff Wells wrote:

Note to readers - Puerto Rican debt is "rated".

NOVEMBER 4, 2013 9:51 A.M.

Misinformed wrote:

The amount of outstanding NR debt is 4-5x higher than the amount of debt with actual below investment grade ratings. Furthermore, the S&P Municipal High Yield Index that you link to in this article is not a market benchmark, it is a managed fund product. It does not replicate any specific market share exhibited by non rated bonds, its just an actively managed fund. So you're rule of thumb is a product of misinformation on the blogger's part.

NOVEMBER 10, 2013 10:19 A.M.

Not a journalist looking for a cheap story wrote:

Puerto Rican debt is bank investment grade rated, because ratings are based on revenues. Puerto Rico earns revenues, is capable, and willing to pay their debt.

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As exchange-traded funds and other investing vehicles have ballooned in number, the task of figuring out what works well and what doesn’t has only gotten harder. Barrons.com’s Focus on Funds looks under the hood of ETFs, mutual funds and hedge funds for overlooked values, actionable ideas and the latest pitfalls for fund investors.

Chris Dieterich has covered the U.S. stock market for The Wall Street Journal and Dow Jones Newswires. He is a graduate of Regis University and the Missouri School of Journalism.